Create an Emergency Fund to Prepare for the Next Recession

By Keisha Chambers, Ph.D.
Faculty Member, School of Business

With the excitement of the New Year, the beginning of 2020 was hitting on all cylinders. The stock market was continuing to break records, unemployment was stable and consumer spending was up. Based on most assessments, the U.S. economy was flourishing.

Then there was COVID-19. The pandemic took us all by surprise; with states locking down and workplaces’ mandatory closures, the economy quickly slowed to an unrecognizable pace.

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At its peak, the U.S. Bureau of Labor Statistics reported that unemployment was at an astounding 14.7% in early spring. And if you were one of the 49 million who filed for unemployment claims, an emergency fund could not have been more critical.

What Is an Emergency Fund?

Investment company Vanguard defines an emergency fund as “a stash of money set aside to cover the financial surprises life throws your way.” Emergencies occur and anything can happen at any time. We do not know when a financial emergency will happen, but preparing for such events can reduce stress and prevent you from going into credit card debt.

Some of the top emergencies that many people face are medical emergencies, home and/or car repairs, and job loss. Regardless of what event may bring about a rainy day, you want to be prepared if and when it occurs.

Saving money isn’t always easy, but the alternative could be more painful. Taylor Tepper of Bankrate once conducted a survey, which revealed that only 39% of households could cover a $1,000 emergency. The survey illustrated that almost one in five Americans would pay for such emergencies with a credit card, financing the balance over time. Similarly, a Federal Reserve Report found that “44 percent of Americans couldn’t cover a $400 emergency expense out of pocket.”

 Vanguard states that the typical rule of thumb for an emergency fund is to set aside between three and six months of living expenses. But as we are all aware, this amount will not be enough for a recession when you can be unemployed for more than six months. Expanding your emergency savings to nine months or 12 months of living expenses provides you with a better opportunity of enduring a recession, job layoff, primary appliance replacement, or health crisis. 

How to Start Saving

The first step to creating an emergency fund is to make a decision to commit to the process of regularly saving money. The most important behavior with saving is discipline.

Take baby steps to avoid feeling overwhelmed, which is essential to getting started. Here are a few additional ideas to consider as you begin regular saving:

1. Find a high-yield savings account that works for you. You want your money to work hard for you as you begin building your stash. Additionally, you want to make sure that your money is safe and easily accessible during times of economic turbulence. Synchrony and American Express are ranked in the top 10 online highest yield savings accounts available.
2. Calculate your monthly expenses and start small. Saving something is better than nothing; if you saved just $25 a week, that would add up to $100 a month. Also, consider picking up a part-time job to build up your emergency fund.
3. Set a goal to have a specific dollar amount at the end of two years. Make sure you do not touch your emergency fund if it’s not a true “emergency.”
4. Reduce or remove unnecessary expenses. For example, cut off your cable TV service for six to eight months, cancel your gym memberships, and cook at home rather than eating out. Redirecting these expenses into your savings account can help build your emergency fund at a faster rate.
5. Get rid of high-interest debt. Motley Fool’s Matthew Frankel states, “if you lose your job and owe $500 per month to your creditors, it can be far tougher to stay afloat than if you didn’t have this obligation. And high-interest debt such as credit card debt is the worst — not only can these obligations eat away at your emergency fund, but much of your minimum payment will go toward interest, not paying down your principal.”

I encourage you to create a savings plan you can stick to, establish and execute. Start planning today for the unexpected!